Possible US-China trade deal lifted markets

Special announcement

South Africa

The JSE followed in the footsteps of most global markets by closing up on Tuesday due to easing trade tensions. At the end of business, the All Share was 0.40% higher and the Top 40 0.52%.

United States

Major US indexes opened Tuesday in the green in hopes that the global economic superpowers will reach an agreement and put an end to market trade friction. Reuters reported that both sides seemed optimistic about reaching a conclusion.

Europe

European markets enjoyed a positive Tuesday on hopes the US and China might reach a deal leading to positive market sentiment. At the close of trade, the STOXX 600 was 0.87% in the green.

Hong Kong

While the Hang Seng managed to rise somewhat on Tuesday as the world’s two largest economies resumed trade negotiations, Chinese shares slipped. At 19h10, the Hang Seng traded 0.10% up, and the Shanghai had lost 0.26%.

Japan

Japanese indices also enjoyed a good Tuesday as global trading sentiment picked up in the hope of a Sino trade deal being struck. At 19h00, the Nikkei had moved up to 0.90%.

Rand

Although the rand broke the R14/$ barrier, the greenback strengthened again on Tuesday in light of the US-China trade negotiations easing tension. At 18h40, the rand traded R13.97 to the dollar.

Precious metals

The bullion market lost some ground on Tuesday as the dollar recovered on hopes of a trade deal between the US and China. At 18h45, an ounce of gold cost $1 284.55.

Oil

Oil prices increased on Tuesday due to the trade negotiations and to OPEC possibly extending supply cuts. At 19h15, Brent crude cost $58.38 per barrel.

Highlights

The largest contributor to Naspers’s net asset value (NAV) remains its investment in Tencent, which is separately listed on the Hang Seng stock exchange.

Tencent was a key contributor to the overall performance and remains the dominant factor in investment returns given its size in the portfolio.

We remain concerned over the stretched valuation of Tencent and we feel that regulatory changes and slower advertising growth due to a difficult Chinese macroeconomic environment, are evolving into significant headwinds.

This might impact earnings from both the gaming and the advertising operations, which are the drivers of sustained earnings growth. Slower growth in these divisions is likely to translate into earnings growth below current market estimates and can place further pressure on the share price.

Our estimation shows that Naspers is currently trading at a 7% discount to our sum of the parts (SOTP) valuation.

Reduced cash burn of internet assets, improved profitability as scale builds, lower development and marketing spend, as well as corporate actions (including the unbundling of the video entertainment division) could lead to a narrowing in the discount.

While the group’s balance sheet has improved after selling investments in Tencent (partially) and Flipkart (completely), potential value-destruction acquisitions remain a concern.

Naspers has significant forex exposure, which could impact the group’s valuation significantly.

Emerging market risk aversion and changes in venture capital’s risk appetite, could have a material impact on the valuation of investments.

Highlights

Given the evolving nature of many of the group’s businesses, determining sustainable growth accurately remains a challenge. With high growth already been priced into the valuation we feel the share is fairly-valued.

Forecasting risk, however, remains high due to regulatory changes and slower advertising growth caused mainly by a challenging macroeconomic environment evolving into a significant headwind.

The group’s leadership position in social media platforms (WeChat and QQ) provides it with significant potential to monetise ad inventory, optimised by data and analytics gathering across its multiple platforms. This should allow it to push more relevant and personalised content, which should translate into higher ad conversion and therefore ad pricing.

The recently announced reorganisation of the company intends to integrate product teams and data better and to improve analytics to deliver personalised content and ads to users. Tencent's advertising penetration is still lagging behind its peers; in the short term, improved adoption is likely to be constrained by a more difficult macroenvironment and the communicated reorganisation.

Sentiment towards China's mobile games industry is likely to remain weak given poor monetisation of survival games and the uncertain regulatory environment. New initiatives such as tournament games and overseas expansion are only likely to contribute in the medium term.

Highlights

We recommend an underweight position in Woolworths as we feel divisions face material, structural and cyclical challenges, which, combined with a strained balance sheet significantly increase their risk profile.

The food operation is the most attractive division; consistently producing sector leading volume growth and market-share gains.

But, we are concerned about the impact constrained consumers will have on medium-term results and the division’s ability to drive efficiency gains further as margins are already on a high base and ahead of management’s medium-term targets.

While we expect results to remain solid, it is unlikely for food to stay the engine for growth, as it has been in the recent past, with the division contributing close to 40% of earnings.

Local clothing and general merchandise is suffering from a cyclical downturn and achieved three-year CAGR (compound annual growth rate) of around 3% while margins declined by a quarter as the division struggled with a poor fashion offering, which assisted international players to gain market shares.

The David Jones operations remain a primary concern as structural challenges in the retail environment are raising fears around the sustainability of its current business model.